Strategic Trading with Information Acquisition and Long-Memory Stochastic Liquidity

Abstract

This paper investigates the strategic interaction of information acquisition and noise trading patterns, as well as its significant implications in market equilibrium outcomes. We consider a market where the strategic trader can dynamically acquire costly information about an asset's payoff via private signals instead of endowing him with its full information. Particularly, the noise trading, which provides necessary liquidity for the market, has the feature of long-range dependence. We provide closed-form characterizations of the equilibriums in both opaque and transparent markets depending on whether or not the trader discloses his order flow. We then find that: (1) the endogenous information acquisition improves the price informativeness over time, while the information efficiency is decreasing; (2) the long-memory stochastic liquidity renders excessive price volatility, enlarges the price impact, and slows down information learning; (3) in a transparent market, the trader shall adopt a mixed strategy by adding an additional noise in his trading strategy to prevent rapid information leakage.